Some investors track their stock investments closely and believe that they need to sell after short holding periods —months, weeks, or even days. With the growth of Internet and computerized trading, such shortsightedness has taken a turn for the worse as more investors now engage in a foolish process known as day trading, where you buy and sell a stock within the same day! If you hold a stock only for a few hours or a few months, you’re not investing; you’re gambling. Specifically, the numerous drawbacks to short-term trading include the following:
1. Higher Trading Costs
Although the commission that you pay to trade stocks has declined greatly in recent years, especially through online trading, the more you trade, the more of your investment dollars go into a broker’s wallet. Commissions are like taxes—once collected, your dollars are forever gone, and your return is reduced. Similarly, the spread between what you pay to purchase a stock and the price you would receive to sell the same stock (known as the bid-ask spread) can be a significant drag on your investment return.
2. More taxes (if you trade US stocks)
When you invest outside of tax-sheltered retirement accounts, you must report every time that you buy and then sell a stock on your annual income tax return. After you make a profit, you must part with a good portion of it through the federal and state capital gains tax that you owe from the sale of your stock. If you sell a stock within one year of buying it, the IRS and most state tax authorities consider your profit short-term, and you owe a much higher rate of tax than if you hold your stock for more than a year. Holding your stock for more than a year qualifies you for the favorable long-term capital gains tax rate. The return that you keep (after taxes) is more important than the return that you make (before taxes).
3. Lower returns
If stocks increase in value over time, long-term buy and hold investors will enjoy the fruits of the stock’s appreciation. However, when you jump in and then out of stocks, your money spends a good deal of time not invested in stocks. The overall level of stock prices in general and individual stocks in particular sometimes rises sharply during short periods of time. Day traders and other short-term traders inevitably miss some stock run-ups. The best professional investors don’t engage in short-term trading for this reason (as well as because of the increased transaction costs and taxes that such trading inevitably generates).
4. Lost opportunities
Most short-term traders tend to spend inordinate amounts of time researching and monitoring their investments. More and more people quit their jobs so they could manage their investment portfolio full time. Some of the firms that sell day trading seminars tell you that you can make living trading stocks. Your time is clearly worth something. Put your valuable time into working a little more on building your own business or career instead of wasting all those extra hours each day and week watching your investments like a hawk, which hampers rather than enhances your returns.
5. Poorer relationships
Time is our most precious commodity. In addition to the financial opportunities that you lose when you indulge in unproductive trading, you need to consider the personal consequences. Like drinking, smoking, and gambling, short-term trading is an addictive behavior. Spouses of day traders and other short-term traders report unhappiness over how much more time and attention their mates spend on their investments rather than their families.
How a given stock performs in the next few hours, days, weeks, or even months may have little to do with the underlying financial health and vitality of the company’s business. In addition to short-term swings in investor emotions, unpredictable events (the emergence of a new technology or competitor, analyst predictions, changes in government regulation, and so on) push stocks one way or another for short periods of time.
Stocks are intended to be long-term holdings and you shouldn’t buy stocks if you don’t plan on holding them for at least five years or more — and preferably seven to ten. When stocks suffer a setback, it may take months or even years for them to come back.
